Bank of Canada holds interest rates steady

The Bank of Canada held its benchmark overnight lending rate steady at three per cent at it’s setting on July 15^th. The trend-setting Bank rate, which is set 0.25 percentage points above the overnight lending rate, remains at 3.25 per cent.

The Bank’s decision to hold interest rates steady aims to boost its inflation fighting credentials. Financial markets widely expected the Bank rate to be put on hold despite the lackluster outlook for Canadian economic growth.

“The Bank is keeping interest rates steady even as sharp increases in energy prices boost inflation, since slowing factory sales to the U.S. are undercutting Canadian economic growth, “ said CREA Chief Economist Gregory Klump. “Interest rates will be on hold over the summer, giving the Bank time to judge the effect of previous interest rate cuts.” To stabilize credit markets in the aftermath of the U.S. sub-prime mortgage market meltdown, the Bank cut the overnight lending rate by 1.5 percentage points from December 2007 to April 2008.

The Bank recognized that while Canadian economic growth in the first quarter was weaker than expected, Canada’s domestic economy “continues to expand at a solid pace.” The Bank expects overall Canadian economic growth to continue being squeezed by weak factory shipments to the U.S. due to protracted weakness in the U.S. economy.

Revising its forecast for economic growth downward, the Bank indicated it expects GDP to grow by one per cent in 2008, then 2.3 per cent in 2009, and 3.3 per cent in 2010. Compared to its April 2008 Monetary Policy Report, this represented a cut in the Bank of Canada forecast for economic growth by 0.4 per cent in 2008, and 0.1 percent in 2009.

The Bank also acknowledged that inflation is running higher than its earlier forecast. “Total CPI inflation over the next year is expected to be much higher than projected at the time of the April Report…total CPI inflation is projected to rise temporarily above 4 per cent, peaking in the first quarter of 2009.” It expects its core rate of inflation, which excludes food and energy, will “remain well contained…averaging close to 1.5 per cent through the third quarter of this year and then rising to 2 per cent in the second half of 2009.” The Bank conducts its interest rate policy with a goal of targeting the core rate of inflation at two per cent, within a band of plus or minus one per cent.

When the Bank left interest rates unchanged on July 15^th, the advertised conventional five-year conventional mortgage rate stood at 7.15 per cent. This is less than one-tenth of a percentage point below where it stood a year ago. Competition among mortgage lenders remains stiff, but discounts off advertised mortgage interest rates have shrunk because the U.S. subprime mortgage meltdown and resulting global credit crunch have raised banks’ cost of funds.

“National sales activity will be down from last year’s record, ” said Klump. “Rising home prices and changes to mortgage default insurance that take effect later this year will continue undermining affordability at the margin.” (CREA 15/07/2008)